USD/JPY has been one of the largest swinging pairs in G10 FX this year. It’s up almost 17% in 2022, trading at 134.50 as we write. From a technical perspective, the pair has flagged up as being overbought several times, yet has continued to push higher. But after understanding the fundemental reason for this move, could it now be time to re-enter shorts?
The reason behind the move
Simply put, the yield differential between the US and Japan is the main reason why USD/JPY has soared higher. US bond yields have shot higher this year, as investors brace for the US Fed to ramp up interest rates. So far the Fed have delivered, and we expect them to raise rates again tomorrow evening. This is a tool used to combat high inflation. By raising rates, consumers are more inclined to save rather than spend.
On the other hand, Japan are actively controlling their yield curve to prevent yields from rising. The Bank of Japan have a mandate to buy an unlimited supply of bonds from the market in order to keep the yields at a set level.
For USD/JPY, it has moved higher in a correlation to the yields. If investors can pick up a higher yield in the US by holdings USD, they will sell JPY to achieve this. So the move higher has gone in sync with the pickup in US yields and the stagnation of JPY yields.
What’s changed now?
Personally, we feel as a team that that US yields are reaching the limits. The 10yr trades at 3.4%, with the curve inverted between 2 and 5 years. This is usually a sign that a recession is on the horizon. Therefore, we don’t think US yields can move much higher. This should act as a natural top for USD.
When we combine this to the overbought technical picture, things start to marry up much better for a USD/JPY short than they did a month or two ago. It is on this basis that we feel more comfortable putting a trade on.
However, we are going to watch the US Fed meeting tomorrow before taking any action, as Chair Powell should provide guidance on the outlook for the rest of the year.